Speak with an experienced advisor! What is PMI? (Private Mortgage Insurance)
PMI is a specialized insurance policy provided by private insurance companies that protects a lender from financial loss if a borrower defaulted on their loan. Most banks or lenders require PMI when you put down less than 20% of your home’s purchase price.
So what is the difference between PMI and Mortgage Protection? We will answer that in this article!
How does Private Mortgage Insurance (PMI) work?
When you purchase a home with a down payment less than 20% of the total value of the home, the bank or lender will require private mortgage insurance or PMI. A PMI policy protects the bank or lender from losing money if your home should end up in foreclosure. PMI will be required on your loan if you purchase a home or refinance a home with less than 20% equity.
PMI typically costs between 0.5% and 1% of your total loan amount.
If you have a $100,000 loan, you could pay as much as $83.33 a month or $1,000 extra per year if your PMI fee were 1%. If you have a $200,000 loan, you could pay $166.66 a month or $2,000 a year if your PMI fee were 1%.
The bank or lender would require you to have PMI until your loan value was reduced to $80,000. At this point, you would have 20% equity in your home, and your loan-to-value ratio (LTV) would be 80%. You could request your PMI be dropped and save the $83.33 to use elsewhere in your budget (with supporting home appraisal information).
If you eliminated your PMI payment and kept making the same payment amount you had been making with the PMI, the extra $83.33 going towards your PMI would now be applied to your loan balance. This would allow you to pay your home off much quicker than just making your minimum monthly mortgage payment (as you would pay down your loan an extra $1,000 a year).
You will be required by your bank or lender to pay your PMI monthly. You may also be provided the opportunity to pay your PMI with a single larger payment option. Check with your bank or lender for options.
What are the advantages of PMI?
PMI can help you qualify for a loan, when you don’t have enough money to put down to have an 80% LTV ratio. Many people don’t have $20,000 to put down on a $100,000 home purchase or $40,000 to put down on a $200,000 home purchase or $60,000 to put down on a $300,000 home purchase.
PMI adds to the cost of your monthly mortgage payment, but it can get you into a dream home you may otherwise not have qualified for, based on the size of your home loan down payment.
When can I cancel PMI?
Your bank or lender must cancel your PMI when your loan balance (LTV) drops to 78% of the original appraised value of your home loan. However, relying on the bank to drop your PMI can cost you a lot of money. Over time, your home will increase in value, which will allow you to drop your PMI sooner than relying on the original appraised value of your home when your loan was issued.
If your home has increased in value since you purchased your home, you can request your PMI be dropped when your loan balance (LTV) reaches 80% of your home’s current value. Your bank or lender will require a current home value assessment to determine what your total equity is versus your loan balance.
How can I cancel PMI sooner?
There are several ways to remove PMI from a conventional loan.
Get a new appraisal
Using our $100,000 home as an example, if you put 10% down and have a 90% LTV ratio, after two years, your loan balance may be $87,000 and your home value has increased to $109,000. At this point, your LTV ratio would be 80%, and you could request PMI be dropped. You would have to provide a current appraisal for your home to do so.
Remember that the bank must drop your PMI when you reach a 78% LTV ratio. Your home will increase in value over the years, and you will make payments that reduce your loan balance. The bank will only use the original appraisal on your home when it was financed to determine when to drop your PMI.
If you provide a current appraisal that shows the home value is higher than the original appraisal, this can help you qualify to drop your PMI sooner.
Refinance:
If you refinance your home, the bank will run a new appraisal on your home. If the appraisal comes in high enough above your loan balance, your bank or lender will not require PMI if your LTV ratio is 80% or less.
Home improvements:
If you add significant improvements in or around your home, this will increase the value of your home. If you add an extra room to your home, a pool, a garage, or any other significant upgrades, it will increase the value of your home. This will adjust your LTV ratio, and you can get a current appraisal and drop your PMI if your LTV ratio is 80% or less.
Make extra payments:
Let’s assume your mortgage payment on our $100,000 home is $750 a month. If you pay an extra $250 a month ($1,000 a month total), you will pay your home loan off sooner. The extra $250 is applied directly to reduce the loan balance. When you make your next mortgage payment, you will not be paying interest on that extra $250 that would have been in your loan, had you not made an extra payment.
After a year, the $250 a month would total $3,000 in extra payments made towards paying down your loan. The savings in interest on this amount each year is significant. You will pay your house off much sooner, with these extra payments being applied towards your loan balance.
What is a “seasoning requirement”?
Seasoning requirement is a term used by your bank or lender that requires you to own the loan for 2 years or more before refinancing your loan to get rid of your PMI. If your home loan is less than two years old, you can request to cancel your PMI, but there is no guarantee it will get approved for elimination by your bank or lender.
How to avoid PMI?
There are a few ways to avoid paying PMI.
- The first way is to put down 20% on your home, and you will not have to pay PMI.
- Some lenders will offer to drop the PMI if you accept a higher loan interest rate.
- Other lenders will not require PMI if you finance with a “piggyback mortgage.”
What is a piggyback loan?
Borrowers with less than 20% down are sometimes allowed by their bank or lender to finance their home purchase with two separate loans. A piggyback loan is his second loan placed on top of the first mortgage. The first loan has an 80% LTV ratio. The second loan (technically a lien) is a revolving line of credit, called a home equity loan (HELOC).
HELOC’s are generally used to finance upgrades and improvements to the home. With a piggyback loan, you would simply use a HELOC to finance a certain portion of your loan to get your LTV ratio to 80%. If you had a $100,000 home, put $15,000 down, and used a HELOC loan for the extra $5000, you would achieve the 80% LTV ratio. This would be an 80-15-5 loan ratio.
A HELOC is a line of credit available for you to use as needed, typically for a limited term, such as five or 10 years. The repayment period may be up to 20 years. A HELOC will have an adjustable interest rate that goes up and down, depending on the current interest rates.
You can cancel your PMI when you have 20% equity in your home. With the piggyback loan, you’ll be stuck with this extra loan until you pay it off.
The interest rate on your HELOC will depend on your credit history. The best interest rates for HELOC loans typically go to people with credit scores of at least 740.
You will also need to consider what the interest rate would be on the HELOC, compared to the PMI monthly payment. HELOC interest rates are fairly low, with current interest rates. As interest rates creep up over time, a HELOC piggyback loan may become more expensive than paying PMI.
After calculating the factors of a piggyback loan versus HELOC, if one is lower than the other, you should have enough information to decide which loan option is more beneficial to you financially.
Are there any other requirements for PMI insurance removal?
According to the Consumer Financial Protection Bureau – here are some other requirements that may be required to cancel your PMI.
- You must file your PMI cancellation request in writing.
- You must be current on your mortgage payments and have a good mortgage payment history.
- You will be asked to prove you have no other liens on your home, such as a home equity loan or home equity line of credit (HELOC).
- You may have to get a current appraisal to show your loan balance is not over 80% of your home’s current assessed value.
Conclusion:
PMI is not MPI.
Private Mortgage Insurance protects the bank; Mortgage Protection Insurance protects you and your loved ones.
Getting rid of PMI will save you money and help you pay off your house sooner (if you apply the PMI against your loan after reaching an LTV of 80%).
